Aero and Rail investment operate at the intersection of financial services and the real economy. The past decade of low interest rates has driven asset values up. Add the five trillion in aggressive stimulus spending passed by Congress and U.S. inflation is at a four-decade high. During the Covid lockdowns transportation operations were streamlined by reducing labor and equipment capacity. Now Commercial Air Carriers and Class One Railroads are struggling to meet demands as traffic has returned. With current elevated manufacturing cost and the U.S. economy unexpectedly contracting in the first quarter, Shippers are hesitant to pay for new equipment. The result? The impact of service disruptions and the inflationary environment has created strong demand for existing midlife equipment. There have been seven consecutive quarters of sequential increases in existing rail rolling stock lease renewal rates. Increases in the first quarter of 2022 have been in the mid-to high teens with average renewal terms of 30 months,[1] and, railcars in storage are down.
Economists are concerned record energy and food prices are creating consumer expectations that will sustain and continue high inflation. Over the last twelve months the Bureau of Labor Statistics reports the gasoline index up 48.7% ($5 a gallon gasoline prices are up 60% from a year ago). The fuel oil index is up 106.7% (the largest ever in the history of the series which dates to 1935). The electricity index is up 12%. The natural gas index is up 30.2% (the largest increase since July 2008). West Texas Intermediate and Brent crude futures is averaging over $120 per barrel. Rising inflation complicates pricing decisions and labor negotiations (United Airlines agreed last week to give their pilots a 14.5% raise through the end of next year). Since March the Fed has raised its benchmark federal-funds rate three times from near zero to a range between 1.5% and 1.75% and is signaling additional increases are coming. Concerns are growing that supply chain disruptions, commodity-price shocks, the risks of a wage-price spiral, geopolitical tensions, and the Fed’s higher interest rates will tip the U.S. into recession. The New York Fed’s internal economic modeling system is predicting a contraction this year and next.[2] “Historical experience points to a significant risk of a US recession in the wake of monetary tightening.”[3] And, the Federal Reserve Bank of Atlanta’s latest estimate (June 30) for 2nd Quarter GDP ‘growth’ dropped to -1% (recall 1st Quarter GDP declined at a 1.6% rate).
Rail service disruptions continue, and Rail Shippers are complaining cars ordered are not being delivered. When shippers are unable to receive cars ordered it disrupts markets throughout the broader supply chain. U.S. Code 49 U.S.C. 11101(a) provides railroads have a statutorily mandated ‘Common Carrier’ obligation ‘to provide transportation service on reasonable request’. The 1980’s Staggers Act removed many government regulations and resulted in an environment that led to rail duopolies in the eastern and western U.S. The Chair of the Surface Transportation Board (“STB”), Martin Oberman feels: “the pendulum has swung too far”. Regulatory risks are increasing as the roads struggle with clearing congestion.
Demand in the Aero and Rail secondary markets is strong and it’s expected to remain so through the remainder of this year. Real interest rates remain negative. Equipment finance firms that adjust operating practices now will be better positioned to compete and thrive. Hard assets with long lives, contractual cashflows, and robust residual values remain attractive. A correction in the economic outlook will create opportunities. Find the best spot market Aero and Rail values. Call RESIDCO.
Glenn P. Davis, 312-635-3161
[1] GATX 2022 First Quarter Conference Call, April 20, 2022
[2] Wall Street Journal, June 21, 2022, Fed’s Bullard, Wary of Inflation
[3] Fitch Global Economic Outlook, June 2022
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